Output Gap

The output gap is a way of measuring how much an economy is running above or below its potential. Think of it like this: the potential output is the maximum amount of goods and services an economy can produce when it’s running at full capacity without causing inflation. The actual output is what the economy is really producing right now.

So, if the actual output is below the potential output, you’ve got a negative output gap. This usually means the economy isn’t doing as well as it could be, often because of high unemployment or low demand. On the other hand, if the actual output is higher than the potential output, you’ve got a positive output gap, which might mean the economy is overheating and could lead to inflation because it’s pushing resources too hard.

In simple terms, the output gap helps us see if the economy is underperforming or overperforming relative to its full potential. It’s a useful way to gauge overall economic health and guide decisions about things like fiscal policy and interest rates.